Apart from the fact that she is German, aged 37, and works for Morgan Stanley, perhaps, until recently, little more of any importance would have been known about her. But you try a ‘search news’ click on Google, and you will see how many times the name of ‘our Elga’ shows up in connection with what we might choose to call the ‘German disease’. (In reality the German economy has expanded by an average of only 1.2 percent every year since 1992, which is the same as the Japanese one – and less than half the growth achieved in the U.S. and the U.K. over the same period – so why don’t we say Germano-Japanese disease? This might help us get a bit nearer to the underlying causes). The reason for this: Elga is fast becoming the best known champion of the view that the key problem facing the Germany economy is the high cost of German labour.
“The reason that we go more to India and those countries is we get highly skilled young people in a flexible labor market for cheap prices,” said Henning Kagermann, 56, chief executive officer of SAP, in an interview at the Cebit fair in Hanover, Germany. “This is highly competitive against our home market.”
In fact the Cologne-based IW economic institute said in a recent survey that German industry’s labor costs are the highest in the world, with 72 percent of 523 companies questioned saying they would hire more staff if the government made headway on lowering the burden. Labor costs — consisting of net pay, welfare insurance and benefits — totaled $23 per hour in Germany last year, compared with $22 in Japan, $20 in the U.S., $17 in the U.K. and $16 in France, the IW said.
According to news in this morning, German unemployment rose for a sixth successive month in July. Also all available evidence seems to suggest that the German ‘revival’ is export driven with internal consumption remaining largely flat. To this picture must now be added the reality that what expanison there is in Europe’s largest economy has so far failed to prompt executives to hire more staff.
So what’s with the Elga Bartsch thing?
Well first of all, take a look at what she was saying last week on Stephen Roach’s Morgan Stanley Global Forum:
Would you believe it? The deflationists are back! Just a year after the deflation debate in post-bubble America reached a climax, driving global bond yields to historical lows, some economists are warning of a new deflation threat being in the making on the Old Continent. Their concern is that the recent agreements reached in Germany, on extending working hours without compensation for the extra hours put in, would cause downward pressure on consumer prices (see German Economics: Reforms Reach the Grass-Roots, July 7, 2004, for more details on the trend toward company-specific deals on pay and working conditions). Hence, the ECB should consider cutting rates in response to these disinflationary, if not deflationary, work-time deals, to prevent inflation from easing towards the deflation danger-zone. We disagree, on four grounds.
Just one quibble, what gives with the deflationists are back stuff, how can people be back who have never really been away:)? Clearly ‘our Elga’ has difficulty getting to grips with the core of the deflation argument, which relates to Germany much more than it does to the US, and to changing global production patterns (the rise of the new Asian ‘tigers’) and to changing global demography much more than it does to the (Irving Fisher style) problem of the debt impact of the burst bubble. Still Elga is far from alone here, so perhaps this is unfairly harsh.
However her arguments about why the impact of the changing work contracts in Germany (and later elsewhere) won’t have a disinflationary/deflationary (take your pick) impact are really pretty outrageous. Essentially she argues two things: that the workers affected are too few to have any impact, and secondly, that the workers affected, not having lost any earnings, should not show any changes in their consumption patterns.
The first of these arguments flies in the face of what Elga herself (and others who advance the same view) have been saying, and the second ignores one key component of economic behaviour: psychology.
In my view, the most promising avenue to improve cost-competitiveness though is through greater flexibility with regard to working hours by either raising the average workweek or cutting holiday allowances. For starters, such flexible arrangements allow companies to react to demand fluctuations without incurring hiring and firing costs. In addition, raising the number of hours worked without fully compensating staff for the additional effort, is a great way to boost cost-competitiveness in the face of a rising euro and EU enlargement. It seems that workers find it easier to put in the extra hours than to accept a pay cut.
I argue that instead of a continuous stream of reform proposals, Germany would need a big bang to restore confidence. In my view, further streamlining of the welfare state is essential to reduce non-wage labour costs. So is further labour market liberalization.
Put bluntly: what Germany needs is a reduction in labour costs and reduction in social welfare expenditure.
Her colleague at Morgan Stanley Eric Chaney elaborates on this further:
There is already a two-speed Europe. Since the first quarter of 1999, peak of the previous business cycle, final domestic demand has increased by 0.3% in Germany, versus 11.2% in the rest of the euro zone. Zero growth in Germany, 2.2% per year on average in the rest of Europe, these numbers speak for themselves. It is not the place to embark in a detailed analysis of this divergence. My colleague Elga Bartsch has written extensively on this issue and, I believe, spotted the main causes of the German disease: excessive wages and wage costs, a counter-productive ?wage cartel?, and a hypertrophied welfare state that is both a burden on companies and workers and a disincentive to work.
One single factor explains this divergence: in the five years that followed the unification, German wages were up 35%, vs. only 15% in France. Since then, German companies have partially restored their competitiveness by substituting massively capital to labor and offshoring production centers to Eastern Europe and now China. However, for the domestic economy, this was done at the expense of capital productivity, which is now so low that the return on capital has become one of the lowest in Europe. Permanent job cuts and, now, capex cuts are just symptoms of the German disease. The root is elsewhere; it is in a wage bargaining system that has fuelled a wage bubble and, then, prevented its correction.
Now it may well be true that Germany has no alternative to this ‘remedy’. My argument is simply that this will undoubtedly be deflationary in it’s impact, and will more than likely only be a palliative, helping things get worse less quickly.
Elga’s suggestion that only relatively few companies are affected is tendentious to say the least: her argument ought rather to be that this is insufficient, and should be spread throughout the German economy. But if the trend is generalised, then the impact surely then will be deflationary. And this for the very good reason that the psychology of the situation will mean that people do feel that their living standard has fallen. They will not feel so affluent, and this feeling is bound to hit consumption negatively. Call it a ‘wealth effect’ if you like.
Also to argue that this is not deflationay since the impact of closing the plants altogether and losing all the jobs would have been more so is simply silly.
The German economy is export driven, there is no escaping this fact. The world economy (and in particular the US and China) seems to be slowing down. This will be felt in Europe. So if your external demand is reducing, and your internal demand is about to take another hit, I don’t see how people can fail to draw the conclusions. Just because there are no easy solutions is no reason to fail to face up to reality. Advocating an exit strategy, but then running away from the conclusions doesn’t seem to me to be the best way of doing things. Of course in referring to ‘our Elga’ here there is nothing personal, she is simply a representative – possibly a rather overquoted one – of a current of thinking. It is the current of thinking which I think is flawed.